Impairment recognition and measurement involve assessing whether an asset’s carrying value exceeds its recoverable amount, calculated as the higher of fair value less costs to sell or value in use. Impairment is triggered by factors such as market declines, technological changes, or internal issues like obsolescence or reduced performance, making regular reviews essential for assets like goodwill, intangible assets with indefinite useful lives, and property, plant, and equipment. If an impairment loss occurs, it reduces the asset’s value and impacts the income statement. Reversals are possible if circumstances improve but are limited to the depreciated historical cost, with goodwill impairments being irreversible. Transparent disclosures, including impairment amounts, triggering events, recoverable values, discount rates, and fair value hierarchies, are vital to ensure stakeholders understand the financial impact.
Asset Impairment
Asset impairment refers to the situation where the carrying value or book value of an asset exceeds its recoverable amount, which is the higher of its fair value less costs to sell and its value in use. The carrying value represents the amount reported on the company’s balance sheet, while the recoverable amount reflects the asset’s potential value from sale or internal use.
When an asset is considered impaired, the company must recognize an impairment loss, reducing the carrying value of the asset to its recoverable amount. These losses are recorded in the income statement and can significantly impact a company’s financial performance. This guide explores the key methods, processes, and disclosure requirements related to asset impairment.
Methods for Determining Recoverable Amounts
1. Fair Value Less Costs to Sell
This method estimates the price the asset would fetch in an arm’s length transaction, less any associated selling costs such as commissions or legal fees. This approach is typically used when there is:
- An active market for the asset.
- A binding sale agreement in place.
2. Value in Use
Value in use represents the present value of future cash flows that the asset will generate over its useful life. This calculation involves:
- Forecasting future cash inflows and outflows.
- Including disposal costs at the end of the asset’s life.
- Discounting cash flows using a suitable discount rate that reflects the time value of money and risk.
Impairment Testing Process
Step-1: Identify Indicators of Impairment
External signals:
- Significant decline in market value.
- Changes in technology, market conditions, or economic environment.
- Interest rate hikes that reduce the value in use.
Internal signals:
- Asset obsolescence or damage.
- Decline in asset performance.
- Changes in the use of the asset.
Step-2: Estimate the Recoverable Amount
- Use fair value less costs to sell or value in use, whichever is higher.
- Perform a detailed analysis, including realistic projections of cash flows and appropriate discount rates.
Step-3: Compare Recoverable Amount to Carrying Value
- If the recoverable amount is less than the carrying value, recognize an impairment loss.
- The impairment loss is recorded in the income statement and reduces the carrying value of the asset.
Step-4: Allocate Impairment in Cash-Generating Units (CGUs)
When individual assets do not generate cash flows independently, impairment testing is performed at the CGU level. The impairment loss is allocated as follows:
- Specific impaired assets are written down first.
- Remaining impairment is allocated to goodwill.
- Any excess is allocated pro rata to other assets in the CGU, ensuring no asset is written down below its recoverable amount.
Reversal of Impairment Losses
If circumstances improve and the recoverable amount increases, previously recognized impairment losses (excluding goodwill) can be reversed. However:
- The carrying amount cannot exceed the depreciated historical cost.
- Reversal is recognized in the income statement, and depreciation schedules are adjusted to reflect the revised value.
Goodwill Exception: Impairment losses on goodwill are not reversible because any increase in value is attributed to internally generated goodwill, which cannot be recognized under accounting standards.
Disclosure Requirements
To ensure transparency, companies must disclose:
- The amount of impairment losses and reversals recognized.
- Events leading to impairment or reversal.
- The recoverable amount and the method used (fair value or value in use).
- The discount rates applied in value in use calculations.
- The level of the fair value hierarchy used in determining fair value.
Additional disclosures, such as assumptions, timing, and the financial impact of impairments, can further enhance transparency.
Key Takeaways
- Impairment Loss Recognition: Occurs when an asset’s carrying value exceeds its recoverable amount.
- Methods: Recoverable amount is determined by either fair value less costs to sell or value in use.
- Indicators of Impairment: External factors (e.g., market decline) and internal factors (e.g., asset obsolescence).
- Reversal of Impairment: Allowed except for goodwill; limited to depreciated historical cost.
- Disclosure: Requires transparency in losses, reversals, and assumptions.
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